Passive funds have soared in popularity of late thanks to their low costs and that, in several key markets such as US equities, they habitually beat the average ‘active’ fund in terms of total return.
In fact, almost half of FE Trustnet readers said they had more exposure to passive vehicles compared to three years ago and only one in five has lessened exposure.
However, with this popularity comes the potential that more investors will be left feeling short-changed should their investment not work out as expected. While active managers try and beat an index, the purpose of a passive is to track the movements of the index as closely as possible. Over time a small percentage difference can amount to frustratingly lower return that you think you have received.
For example, while they track the same index, some passive funds have delivered vastly different performance to others over the years.
While the likes of £191m Scot Mutual UK All Share Index was just 0.38 of a percentage point out, the £2.3bn Halifax UK FTSE All Share Index Tracker returned just 73.65 per cent meaning investors have been left with a hefty 30 percentage points hole in their returns.
Then there is the £1.2bn Halifax UK FTSE 100 which has returned 56.89 per cent over the same period while the FTSE 100 gained 91.36 per cent, meaning it has been nearly 35 percentage points off the mark.
Performance of best and worst FTSE All Share tracker over 10 years
Source: FE Analytics
Darius McDermott, managing director of Chelsea Financial Services notes that of the 116 passive funds available to UK investors 20 – with assets totalling £20bn - are missing their benchmarks by a substantial amount over the past three years, five by at least four percentage points. The firms puts these trackers in what they call the RedZone.
“In the passive vs active debate, we acknowledge that there are good and bad fund managers, and our business reflects that – we have a research team, who spend their time finding the fund managers who we think can consistently outperform in any reasonable time period, while the RedZone highlights the ones which have shown they don't have this ability. But there are good and bad tracker funds too and they need just as much research before you invest.”
In order to generate greater transparency within the tracker market, FE recently launched its own Passive Fund rating which allows investors to objectively compare conventional trackers and exchange traded funds.
Looking at tracking difference, the variance of return over three years between the index and the passive fund, here are those that have ‘done what they say on the tin’.
UK
The Vanguard FTSE UK All Share Index fund, which carries highest rating, has the lowest tracking difference of any fund in the IA UK All Companies sector over the last three years – just 0.04 per cent, relative to its All Share benchmark.
Performance of fund and index over 3yrs
Source: FE Analytics
Like all good trackers, the fund replicates the make-up of its benchmark, varying the increments of each company depending on how they perform. As you’d expect, the largest holdings at the moment are giants HSBC, Royal Dutch Shell and BP.
It has a clean ongoing charges figure [OCF] of 0.08 per cent.
US
As it is especially difficult to consistently beat the US equity market, according to our data, picking the right tracker is particularly important.
Equities in the US have been one of the best places to be in the post financial crisis market and yet many professional investors have increasingly opted for passives such as Equilibrium’s Mike Deverell.
He explained: “We’ve tried several times to find a decent, actively-managed US fund and there seems to be very little consistency in that sector. I’m not going to speculate why active funds tend not to do that well in the US, but we definitely prefer having passive funds there.”
The HSBC American Index has the lowest tracking difference over three years. It has returned 63.61 per cent versus the S&P 500’s gain of 63.43 per cent.
Performance of fund and index over 3yrs
Source: FE Analytics
It has a clean OCF of 0.18 per cent.
Europe
Numerous FE Trustnet studies have shown that the IA Europe ex UK sector has been one of the best hunting grounds for active managers. Nevertheless, more cost aware investors may want to turn to trackers for their continental exposure and FE data shows there have been some which have fared better than others.
Over the last three years, the fund with the lowest tracking difference to the MSCI Europe ex UK index within the IA Europe ex UK sector is another from HSBC.
The HSBC European Index has returned 57.98 per cent compared to a gain in the index of 58.09 per cent.
Performance of fund and index over 3yrs
Source: FE Analytics
It has a clean OCF of 0.18 per cent.
Emerging Markets
Volatility in emerging markets has been shown to be consistently higher than in most developed equity markets which – in contrast to the US – increases the potential for both greater outperformance and underperformance.
Vanguard triumphs again in this asset class with the lowest tracking difference over three years. The $7.4bn Vanguard Emerging Markets Stock Index has returned 12.14 per cent while the MSCI Emerging Markets index gained 12.01 per cent.
It has a clean OCF of 0.27 per cent.